Market Overview

Bank Investors: Here's What's Going To Be A 'Huge, Huge Market'

Bank Investors: Here's What's Going To Be A 'Huge, Huge Market'

Deep value investor Tim Melvin had the opportunity to speak with Nate Tobik of Complete Bank Data and Below is a full transcript of their conversation.

Benzinga: Hey Nate, how are you doing?

Nate Tobik: Good.

BZ: Alright. We're on today with Nate Tobik of Complete Bank Data and Nate, thanks for taking some time to spend with us talking about banks and the stock market today.

NT: Thanks for having me on, Tim. I appreciate it.

BZ: No problem. How are things in Pittsburgh? Everybody getting excited about the Pirates?

NT: I'm not much of a Pirates fan, but I'm excited about the Steelers. So I got the whole antennae thing going on, or headset, or whatever they call that.

BZ: Yeah, a little technical malfunction up there in New England this week.

NT: Yeah.

BZ: Well, we'll talk about that more during the year, because of course, I'm a big Raven's fan, and they're two of the favorites to win the IAFC this year. So, it should be an interesting year.

NT: Yeah, for sure. I grew up in Cleveland, so I've always disliked the Ravens because you guys essentially took our football team in the '90s there. I don't think anyone's left, but...

BZ: I really think you should blame that more on Indianapolis, because they sort of stole ours first. At least we left you the name.

NT: That's true. I will give points to— your coach went to Miami, and so did I, so there's that common link there.

BZ: Now, in addition to football, we both share an interest in the smaller bank stocks out there, the small regional community banks. How did you come to get interested in this sector? Because there's just not too many of us that focus on this area.

NT: No. So, when I started investing originally, I did not invest in any banks, because I was under the belief that they were just too complicated to understand.

So, I started writing this site, oddballstocks, a couple of years after I got started investing, and through that, met someone who's now a friend who said, "You should take a look at these banks. They're really simple to analyze once you get in there, and they're all the same."

In the sense that, when you learn how to look at one bank, you now have roughly 1,200 other companies that all operate in the exact same way. Whereas, even companies in the same sector – so if you're looking at oil and gas companies – they're all similar, but they're not the same. They all do things a little differently. There's little twists to their business.

That doesn't really exist in banking. Banking is, all these companies are doing the same exact thing. And they have some sub-business lines that are a little bit different. But a majority of their business is the same.

So, he encouraged me to take a look, and I started working through some of these balance sheets and income statements of banks, and he was right. And so, I started looking at banks. This was back in maybe 2010 or 2011 when you could buy a profitable bank with 3 percent or less of non-performing assets at 50 percent of book value, and there was just really nothing wrong with these things.

And so, I started buying small banks. And I kick myself now, because I should have put all my money in these bank stocks, done the John Temple Ten approach where I just divided up what I had versus how many of these cheap banks there were. And I would have done incredibly well.

But instead, when you're looking at a cheap sector, there's this temptation to pick the best of the cheapest. So, I was caught up in this when I looked at Japanese nets a couple of years ago. The same thing happened with banks, where I'm looking at all these banks at 50 and 60 percent of book value, some were even less, and I'm thinking, "I wanna find the best operator. So, within that subset of cheap banks, who's got the best returns on equity? Who's got the best credit portfolio?"/p>

And that's been a trap I've fallen into. And I've since learned that you don't have to look for the best. What you need to look for is, make sure it's not bad. Is the credit portfolio in good shape? If it is, and business is recovering, you could pretty much take a bet, and unless the economy goes down the drain, you're gonna do well. And buying a basket of these small banks or small, cheap companies, in general, is such a good method, and it's better to just buy a bunch than it is to try and find the best and get caught up in sorting through trying to predict which cheap banks will do well, or which cheap stocks will do the best. Because we don't know the future.

BZ: True. You talked about something real important there, and that's most people conceive of banks as these hugely risky, complex companies. And once you get outside the biggest four or five banks, that's simply not true. Now, anybody that tries to analyze Bank of America fails the class automatically, in my opinion, because there's too many moving parts. But when you get down to a small, original, community bank, that's just not the case. They still operate like Bailey Savings and Loan for the most part.

NT: That's correct. So, I always explain to people, I say, banking is the simplest if you step away from the financial statements and just think of it as, a bank is connecting people who have money with people who need money. So, people who have excess money put their money on deposit in a bank, and the bank is this intermediary.

They're essentially managing this bond portfolio across a portfolio of loans, and they're assessing risk. They make a little money from the loans that they offer from people, the ones who need the money. They pay a little bit to the providers of capital. They pay their operating expenses out of that spread. And then the rest of that is profit.

And it's very simple.

I think what confuses investors is that whole mechanism happens mostly off the balance sheet. So, when you look at a traditional industrial company, you look at the income statement first, and want to see their profitability, how are they pricing their products, to make sure they cover their costs, their good[s] sold, etc.

Related Link: The Future Of The Small Bank Industry With Sunshine Bancorp CEO Andrew Samuel

Whereas, a bank needs money from people who have it, the deposits, and then they need to be giving it away to people who need the loans. And that's all captured on the balance sheet. The difference of those two amounts is their equity, and that's the bank's book value. So, once you start to get in there, it's simple, but it's just a little bit different.

And that small hurdle in understanding a bank and how a bank's financial work, seems to be enough to keep most investors away.

BZ: It really does. I've been doing this a little longer than you, because I'm a lot older than you on the bank side, and I'm amazed how resistant people are to the idea. Sometimes I feel like I'm pointing at a pile of money and they're just going, "Nope, that's not possible, so I'm not going over there."

NT: Yes. Some of the hesitation, I think, is because banks are levered. They're a levered institution. Leverage, always, is an issue. And that adds risk. And that's why credit quality is paramount.

But a stat I like to toss around is, during the financial crisis, the worst banking crisis we've had since the '30s, only 10 percent of the country's banks went out of business. That's compared to, you see the small business stats of something like 70 or 90 percent of small businesses are out of business within five years of starting. I think that average Joe on the street would say, "Investing in my brother in law's hamburger stand, or their widget company, as an angel investor, is not risky, whereas investing in a bank is extremely risky."

And there are always bad actors in an industry. But banking is focused on managing risk, and even in this terrible crisis, we only had 10 percent go under.

So, 90 percent of the industry did manage risk alright. I think that's significant.

BZ: I do think so. Now, you said that you wished that back in 2010, you had just bought a basket of these things and not tried to nitpick through it. Prices have improved somewhat, but how do you see the smaller regional community banks now? Can you still buy a basket of these things?

NT: You absolutely can. I'll pull it up right now, I've got a little chart. I've got this chart up of price to book ratio on the x-axis, return at equity on the y-axis. I would still say there's probably 25 percent of the traded banks that are trading at 1x book or less. These things, they cluster around about 5 percent return on equity. But, there are a number at the 10 percent mark. So, somewhere between 5 and 10 percent is where they almost all are. And most of these banks are about 80 percent of book to 1x book. That's a huge hunting ground for anyone who wants to build a portfolio of these things.

BZ: Yes, yes it is a very big hunting ground. One thing, looking at the 5–10 percent return on equity, when FJ Capital did their recent M&A white paper, they pointed out that most of the activity was in banks with below 5 percent return on equity right now. Those were the targets that were getting bought. Those higher tended to be the buyers.

NT: I would agree with that. That seems to make sense in that – this environment that we've had with the low rates, the net interest margin compression and the compression from the rates – it needs to change at some point.

And really, the banking environment is split into maybe two groups. This is a very broad statement.

There's the bankers who learned how to adapt and work in this environment. And these are the banks that are seeing loan growth, seeing income growth, they have high returns on equity. And then there's these other banks that just sit and complain about how bad the environment is. Fundamentally, there's some areas of the country that are a little better or worse than others. But fundamentally, everyone's in the same spot.

So, it's a matter of how flexible the bank has been in changing their business and being able to adapt versus the "we're waiting until 6 percent rates come back." And there's a guy in Pittsburgh here who said, he thinks rates should be about 6 percent, and that's when they'll start to deploy their cash. He might be waiting a very, very long time, measured in decades.

BZ: Yeah. I'm in complete agreement these days, with Louis Navellier. I talked to him a couple months ago, and he's got a deep economics background, used to work for the Fed. He said flatly, "I don't expect them to raise rates meaningfully in my lifetime." And he's not that much older than me, and I'm pretty sure he's healthier.

NT: Yeah. I think that's the sentiment for a lot of people. So, maybe they go up a little bit. Maybe they go up a percent. Maybe 2 percent at the most. And that might be it. And the period of time that they can go up to that over might be, we might have another eight or 10 years. We're just stuck in this situation, and I'm not an economics person.

I took— I always like to joke, I took one econ class at college where I skipped so many classes I probably shouldn't have even gotten credit, but I was able to escape with a C-. So, I'm not the person to talk to about econ. But I think that it's a really interesting environment. The tough thing with economics is the same thing as with politics, it's that you can do something today, but it might take five years, 10 years, 20 years before you see the consequence of your action. Oftentimes, the person who's dealing with the consequence is not the person who put the thing in place in the first place.

And so, it's very hard to react. It's— everyone's in this reactive mode all the time, because it's like, "Oh, some other guy set up this problem that I'm not dealing with," and then a fix goes in that creates a problem for someone in the future. And it's not testable. Whereas, if you have a business, you could say, "We're gonna try this advertising campaign. It didn't work, we'll try a different one. We can see the results immediately." And in economics and in politics, you don't have that. It's such a longer time range.

BZ: Now, those of us that are elderly, like myself, have been around a while. I was actually in the business back in 1987. That's the year the number of banks in this country peaked. It's been going down ever since. Now, there's some signs that the consolidation trend is about to accelerate. What do you see happening there?

NT: I think it will. Back to the point about these two groups – the guys who haven't figured it out, I know this is something you said, a lot of them are in their 60s, their 50s and 60s, some are in their 70s.

And if you just haven't figured it out and you're not gonna change, you don't have the energy to change your business at this point, it's easier to sell, get a pay day and go play golf. And I think that's what we're finally hitting is, a lot of managers are just throwing in the towel and saying, "You know what? I'd just rather take my payout, retire and someone else can deal with it. They can do the mobile, they can do the lending club type stuff, because I'm done, the environment's changed."

And so, I think hunting for banks that could be acquired is a good strategy. Oftentimes, these are cheap banks with less than ideal operating metrics. But another strategy is buying the acquirer, and these are often very savvy operators who are building empires. And you buy a share of one of these banks and go along for the ride.

BZ: Yeah. If you look at banks like Bank of the Ozarks and some of the other big acquirers, their stock performance has just been dramatic over the last six years, as they've been buying assets on the cheap. It's been a tough six or seven years for bankers. The regulatory costs are something that everybody's talking about. Can you go into a little bit of what's happening there?

NT: Yeah. The regulatory costs are definitely an issue. I think what people have trouble with is, they are not evenly distributed throughout the industry. So, based on personalities involved in banks, past operating history in the banks, the environment, who the regulator is— you could have one small bank who is drowning under regulatory pressure, and then 200 miles away, another bank of a similar size that says, "We don't have any issues at all."

And so, it's very difficult to get a handle, whereas, some major regulations that come down, you can see an impact in everyone equally, and you can model out what that might be. But a lot of these regulations since the crisis are not even-handed, and that's because there's a lot of factors that we don't have, we're not privy to that information. So, we don't know the personalities involved or what missteps they took in the past that were handled by the FDIC that never made it to a press release but the regulator knows what's going on. So, we can't see this.

All we can see is that some banks are saying, "This is terrible and I'm hiring staff to deal with this," and other banks that are some very small banks, they say, "We don't have any issues at all." The banks that are having issues, I think, are more than likely to be acquired in the long run.

BZ: Yeah. Ted Peters, who just left Brimmoore Bank after a long and successful career, speaking of great acquirers, and has put in a hedge fund to invest in these small banks, and that's one of the things he's looking for, he told me, is banks operating under consent order are more likely to sell than those that are not.

NT: Yes. Well, he bought First Bank of Delaware, which was—

So, if you want to talk about a strange regulatory situation, First Bank of Delaware was sued, I think, or, they came under an order for processing fraudulent checks or some sort of a fraud. Customers were conducting credit card fraud, or some sort of fraud, to their system. And in the past, that sort of an issue had been less than a million dollar fine.

What ended up happening to First Bank of Delaware was, it was some punitive fine that was, I don't have the number in front of me, I want to say it was like $16 or $20 million, which wiped the bank out. This bank was not a big bank to start with. And they ended up having to sell distressed. And yeah, they sold to Tom Peters, you said? He purchased them, and he got a really good deal on it.

BZ: Yeah. They did that as an asset sale, too, didn't they?

NT: Yeah.

BZ: They sold the assets, not the bank.

NT: Yes. He picked up the deposits and all of the good loans. He paid a very slight premium.

BZ: Right. And then, as I recall, the bank sold everything else they had left and returned a very small liquidating distribution to the poor shareholders.

NT: Yeah.

BZ: Alright. So, one of the other things, and I'm seeing this, and when I'm talking to the bankers, it's a huge concern, and that's cybersecurity.

NT: I have heard the same thing. Security is a huge buzzword right now. I think this is something where, when you look at regulations and regulatory issues, banks seem to have a handle on it, because they're a regulated industry. So, they already understand how to deal with regulation.

You get new regulations, there's already a framework to put that into place and handle it. What they don't have this framework for is cybersecurity. I always like to think of the community bank as this hometown bank with a few branches and some very friendly people that you meet at the t-ball games. Those aren't the guys who are staying up late at night, thinking, "If I were to be hacked, what attack vector would [SKIP]." That's just not how they think. That's not the way they operate. But, that is required to protect these assets.

Banks are a giant pot of cash sitting out there. So, the cybersecurity angle is enormous. And I know a lot of banks, they believe there's some security through their core data processor and through some outside vendors. But, the problem is that small community bank who doesn't really understand this, it's hard to buy services or to protect something if you don't even quite understand the whole process and what you're protecting or how it needs to be protected.

And I think that's gonna be huge in the next few years.

BZ: Yeah. The cost of it, in some of the bankers I'm talking to, just the sheer cost and scale of what they see developing there, is causing them to re-think their decision to remain independent.

NT: Yes. Because, some of the larger banks, they have teams around this. And I've actually worked with some people who've gone onto those teams. So, say a Region's [Bank], they have a department of security. And these are some incredibly bright people. Or 5/3. Any of these larger banks. These are really smart people who, all they think about is, how would we hack this bank, our own bank, and let's protect all of those attack vectors. And they have the resources to provide for departments like that. So, they have this defensive team.

And a small bank just doesn't have that. And when I say small, I would say banks that are less than $10 or $20 billion, probably don't have the resources to pull in a team like this.

BZ: I completely agree. I'm gonna steer a little off course, because there is a huge opportunity in cybersecurity. The company that's going to be a huge player in it is a shocking surprise to me.

NT: What's that?

BZ: It's Unisys, ticker UIS. This is the ultimate old tech company. Been around forever. I can remember the original merger that created them with Story and Burrows, I think it was, back in the '80s. But, they have a product called Stealth. It's a cybersecurity defense product. So, I was on a conference call with the CEO not long ago, and he said, specifically, "Our market is commercial banks. That's what we're going after. This product is perfect for them."

NT: That's really interesting. I'll have to look into seeing how they do this. What seems to be the way these things work is, it'll be a product that sits in front of the bank. So, if you were to log in to your bank's website, you actually would be routed through this Stealth product or a similar product, and they essentially clean the traffic, and by the time it actually gets to the bank, it's safe. It's almost insurance.

BZ: But this is going to be a huge, huge market. If you look at the company markets across the board, we've got Internet valuations in those things, because everybody knows it's gonna be a big business. These things are trading at 100x minuscule earnings. But Unisys, you can kind of get in front of it, specifically on the bank side, at a very reasonable price. Anyways, there's my plug for an off the radar stock.

NT: It's funny how this works. My first job out of college was at a cybersecurity firm as a startup. And they were just way too early. And they ended up being merged into this other company. It wasn't a good situation. Business wasn't super healthy. They were too early. If they could have hung on, they could have still been around now. I think the outcome would have been much different.

BZ: Absolutely. Alright, let's talk banks a bit. Do you have any favorite banks that you think are attractive?

NT: Yes. I have a number of banks I like. I know one strategy you really like is activist investors. Two banks that I like are Polonia BankCorp and West End Indiana. Both of these, the shareholder register is just filled with activists. So, both of them are former mutual banks that had de-mutualized. So, they IPO-ed to their customers and outside investors. And they've all been operating – I think West End Indiana has been operating almost three years now, or maybe it has been three years, they might have done their IPO in 2012. And then—

BZ: That's critically important, by the way, because there's three years standstill after conversion on change of control events. So, it's almost like a little CD. It's maturing.

NT: It's maturing. And Polonia, it might have been 2012 or 2013, I don't remember exactly. They're coming up on the anniversary as well. When you have this many activists—

West End Indiana has a nice little franchise where they're at. It's in rural Indiana, actually very close to where I went to college, in Richmond, Indiana, and some other small farming towns. Their operating metrics are okay. Polonia, though, is really a pretty terrible operator. The fact – I don't have the number in front of me, I think it's 38 percent of their ownership is activist bank investors. And so, management owns almost nothing. To me, that says, if you're not a great operator, your three-year anniversary's coming up – this bank is going to be sold because there's really no way to stop it.

BZ: Well, two of the biggest activists, Joseph Stilwell and Arch Seidman, have pretty much told these guys, "Look, you don't know what you're doing; sell the bank." And the stock is still pretty cheap. It's not ridiculously priced at this level.

NT: It recently turned a profit. They've been growing their earnings slightly, but on an absolute level. I just pulled it up, their price to earnings ratio is 172. So, they're barely making money. But the loans and deposits have value to someone else. And once you strip out all the overhead from these guys, I think it's probably worth 1.2x book, 1.4x book.

BZ: Probably 1.2, given the operating metrics, because they do have a very low return on assets and equity at this point. So, I would say probably 1.2. But that's a big pop over today's price.

NT: It is. So, something like that's worth keeping an eye on. The credit quality is decent for the company. And West End Indiana, I think there's more upside in them, ultimately. The ticker for that is WEIN.

BZ: I don't expect Polonia to be around much longer at all.

NT: No. So, West End Indiana is slightly below book value, and I would say that they're worth probably the same: 1.3, 1.4x book. That would be almost a 50 percent increase from here.

BZ: Yeah. I look at this almost like arbitrage. If I buy it at 85 percent book, my target is about 1.25 getting out. And if you've got activists and it's an under-performer, it's when, not if, to a very large degree right now.

Especially in those under $500 million of asset size. I don't think you can remain independent below that line for long.

NT: No, you can't. Just a simple example, West End Indiana, their efficiency ratio is 68 percent, which, all told, really isn't too bad for a community bank. But a lot of banks are shooting for the 50s.

So, if you were to just reduce expenses by, as, 18 percent, get down to 50 percent to an acquiring bank, and then you were to add back in that saved overhead without any synergies from the additional asset base, you could pretty much back into a value that's right about that 1.3, 1.4x book value.

BZ: Right. It's all a matter of - I was talking to the CEO of Sunshine Bank in Plant City, and he said, "Look, it's a matter of scale. You have to scale up. You don't have any choice. You're either going to be a buyer or a seller sometime in the next few years." He's a sharp guy, he's definitely gonna be a buyer, I think he'll be along for a long time. I really like that little bank.

Let's see... complete bank data, this is a cool product you've put together. It's a database, and it's really designed to help investors locate, uncover and research these little banks. Can you tell us a little bit about it?

NT: Sure. It grew out of my own frustration. I was looking at banks and I wanted to screen for banks that had certain bank operating metrics, essentially. I couldn't find a product. There are some professional level products that actually make Bloomberg look cheap. So, they're very expensive.

Related Link: What You Don't Know About Banks Coudl Fill A Book

And so, I knew that you could get the FDIC call data for free from the FDIC's website, so I partnered up with a friend of mine who programs, and I said, "Let's just build this little screener thing for over this FDIC data." Well, that grew wildly. We started pulling in a lot more data. But it started out as, I wanted to build this tool for myself to screen for very specific bank metrics. And so, we began this journey. We continue to build a product, and we actually started pulling in a lot more data. So, now we have FDIC call report data, so you can get very granular details on banks. We pulled back the holding company financials from the Federal Reserve.

We're now pulling in real-time SEC filings for banks, and that'll be live very soon, as well as we have the insider holding information from the Y6 filing.

So, one thing that's going to be really interesting with that is, a problem investors face with small banks is they can't find accurate share counts. So, a lot of these OTC banks, there's no idea how many shares are out there. So, it's very hard to say it's at 80 percent of book value, because nobody knows what the true market cap is or book value per share. So, we've closed that gap by getting the insider filings on 3,000 holding companies, and some of these are some very small traded banks. So, now we could create those statistics ourselves. These are our banks that are essentially non-filing.

But what's interesting is the amount of data that we pull in from these different public sources, you could build a complete investment picture and have more information than you would get from SEC filings without ever actually getting the annual report for a bank.

Sometimes people get a little leery about investing in something where you can't get a hold of an annual report, where you have to call a CEO to get it, but the amount of data that's available on a bank is really so comprehensive compared to any other type of company. We have data back to 2003. It's historical, it's comprehensive and you could build a complete investment picture. That annual report is something that a lot of times feels good, but there isn't as much value added there.

BZ: That's very true. People tend to think that banks are not transparent, but when you realize that they have to file all their stuff at two or three different agencies at different levels of the agency, it's actually possible to get an incredible amount of information. I will say, I use complete bank data. I think it's an incredible product. Really is a time saver. Because, if you try to dig through the call reports and the 10Qs and 10Ks, you're talking hours for each bank. I could pull it up in... well, I'm not real good with computers, so it takes me two or three minutes to pull the information up there. How do you price that for folks?

NT: Currently, the price is $500 for an individual and $200 for a professional account. We have a version on the Bloomberg terminal, so if you're a Bloomberg user, you could type the keyword "APPS BANKS" and then hit go.

And that is priced per terminal, and that's $300 a month. There's a lot more features in the Bloomberg version, though, compared to the web.

I will say this for listeners – if you were thinking of subscribing, I would probably do it soon, because we're going to be re-vamping a lot of our features. We have a lot of new things coming out soon. Pricing will be going up. So, this is the time to act.

BZ: It's a common theme, because we're doing the same thing right now with the bank newsletter product, because of the time involved getting the research and the limited liquidity. We're raising the price this month too. So, you guys gotta get busy and spend some money out there. Now, you have another product that's cool. That's Can you tell me a little bit about that?

NT: There's always this allure to finding something that not many other people have information about. And so, I like these unknown banks, and I also like unknown companies. So, a lot of times at oddballstocks, I just write about companies that are not mainstream. These are not esoteric trades, cotton futures or anything with derivatives.

A lot of times, it's just a sleepy company, and it's trading at a very low valuation, because people don't seem to care about sleep companies. Everyone wants to invest in whatever's hot. So, electric car companies or online CRM management, not a company that is a funeral parlor operator, or they make sensors for pools. So, there's a lot of opportunity in these companies, because they're neglected by

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